It has always taken the Internal Revenue Service time to review tax returns. Recent budget cuts add to these delays. The odds are that any letter from the IRS will relate to an issue from several years ago. If a mistake in a filed return resulted in a tax deficiency for a business, the penalties and interest start accumulating from the date the tax was due.
The agency generally has three years to conduct an audit. The review process begins with a computer that compares a return against "norms" for similar returns in an industry. Discrepancies will flag a return for an auditor to review. If the auditor finds an error or needs more information, the IRS will send a letter to the taxpayer.
An example illustrates what can occur
A small construction company made a mathematical error in withholding payroll taxes for its 10 employees in tax year 2013. It received a letter from the IRS two years later stating that it had failed to withhold $350,000. The tax bill was now over half a million dollars. Penalties and interest accounted for the additional $150,000 the company owed.
As a side note, small business owners and entrepreneurs need to be particularly cautious with payroll taxes, because they can be held personally liable for taxes owed. Chapter 7 or a liquidating bankruptcy cannot discharge payroll taxes either.
How to stop penalties and interest
The first step is to ensure the back tax amount is correct. It may be necessary to challenge the audit in some situations. A rule that could be interpreted different ways could be one reason to fight back.
With our scenario, the company acknowledged that a new bookkeeper made a math mistake and agreed with the IRS calculation. However, the company did not have cash sitting around to pay such a large and unexpected tax bill.
An installment agreement with the IRS allows for more breathing room. A business can stretch payments over 72 months. Unfortunately, this does not stop penalties and interest from accruing while paying down the balance.
Offer-In-Compromise installment agreements are similar with one important difference: an OIC will stop interest and penalties from accruing while paying the balance. An OIC may even result in partial forgiveness of the tax balance.
Whenever an IRS letter includes a past due balance, act fast. Dealing with the issue is not always pleasant, but putting it on the back burner only makes matters worse. The IRS has many tools to collect past due taxes. The IRS frequently uses liens and levies, and it may even go after your personal property.
What is the best solution for you?
It will vary based on your individual circumstances. The experienced tax attorneys at the Seattle office of Insight Law can offer a tailored strategy to resolve the audit and deal with back taxes, penalties and interest.